Dissolution of Partnership Notes1

Study Material & Notes for the Chapter 7

Partnership - Dissolution of Partnership

I.   DISSOLUTION OF PARTNERSHIP –BASIC CONCEPTS

A.  Meaning of Dissolution of Firm
  • According to Section 39 of the Partnership Act 1932, the dissolution of partnership between all the partners of a firm is called the dissolution of the firm. 
  • It is the breaking or discontinuance of relationship between all the partners which is termed as the dissolution of partnership firm. 
  • This brings an end to the existence of firm, and no business is transacted after dissolution except the activities related to closing of the firm. As the affairs of the firm are to be wound up by selling firm’s assets and paying its liabilities and discharging the claims of the partners.
B. Meaning of Dissolution of Partnership

Dissolution of a partnership means termination of old partnership agreement and a reconstitution of firm due to admission, retirement and death of a partner. In dissolution of a partnership the remaining partners may agree to carry on the business under a new agreement.

C. Distinction between Dissolution of Partnership and Dissolution of Firm:

Basis

Dissolution (Reconstitution) of Partnership

Dissolution of Partnership Firm

Meaning

Dissolution of partnership means change in existing relations of the partners.  The firm continues its business.

Dissolution of a firm means the dissolution of partnership among all the partners of the firm and the firm’s business is closed

Closure of books

It does not require closure of books of account because business is not closed.

Books of Account are closed as the business is closed

Court’s Intervention

Court does not intervene because partnership is dissolved by mutual agreement 

A firm may be dissolved by court order

Settlement of assets and liabilities

Assets are revalued and liabilities are reassessed 

All the Assets other than cash are realized and liabilities are paid

Economic Relationship

Economic relationship between the partners changes

Economic relations between the partners comes to an end

Continuity of business

Business of the firm continues

Business of the firm comes to an end

Effect

Dissolution of partnership may or may not involve dissolution of firm

Dissolution of firm also means dissolution of partnership

D. MODES OF DISSOLUTION OF PARTNERSHIP
1) MODES OF DISSOLUTION OF PARTNERSHIP
  1. all the partners give consent
  2. as per the terms of the partnership agreement
2) Compulsory Dissolution
  1. When all the partners or all excepting one partner becomes insolvent or of unsound mind.
  2. When business of the firm becomes illegal
3) On Happening of an Event or Contingent Dissolution–
  1. On expiry of the term for which the firm was constituted
  2. On completion of the venture
  3. On the death of a partner
  4. On adjudication of a partner as insolvent
4) By Notice

In case of a partnership at will, the firm may be dissolved if any one of the partner gives a notice in writing to the other partners.

5) Dissolution By Court - Court may pass Order for the dissolution when
  1. A Partner becomes a person of unsound mind
  2. A partners becomes permanently incapable of performing his/her duties as a Partner
  3. A partner is guilty of misconduct which is likely to adversely affect the business of the firm; 
  4. A partner persistently commits breach of partnership agreement;
  5. A partner transfers his/her interest in the firm to a third party;
  6. The business of the firm cannot be carried on except at a loss
  7. The court regards dissolution to be just and equitable.
E. Settlement of Accounts on Dissolution of a Partnership Firm (Sec 48)
  • In case of dissolution of a firm, the firm ceases to conduct business and has to settle its accounts. For this purpose, it disposes off all its assets for satisfying all the claims against it. 
  • In this context it should be noted that, subject to agreement among the partners, the following rules as provided in Section 48 of the Partnership Act 1932 shall apply. 

(a) Treatment of Losses:-

Losses, including deficiencies of capital, shall be paid :

(i) first out of profits, 

(ii) next out of capital of partners, and 

(iii) lastly, if necessary, by the partners individually in their profits sharing ratio. 

(b) Application of Assets

The assets of the firm, including any sum contributed by the partners to make up deficiencies of capital, shall be applied in the following manner and order:

(i) In paying the debts of the firm to the third parties; 

(ii) In paying each partner proportionately what is due to him/her from the firm for advances as distinguished from capital (i.e. partner’ loan); 

(iii) In paying to each partner proportionately what is due to him on account of capital; and

iv) the residue, if any, shall be divided among the partners in their profit sharing ratio.

F. Firm Debt and Private Debts (Sec 49)

Where both the debts of the firm and private debts of a partner co-exist, the following rules, as stated in Section 49 of the Act, shall apply. 

  1. The property of the firm shall be applied first in the payment of debts of the firm and then the surplus, if any, shall be divided among the partners as per their claims, which can be utilised for payment of their private liabilities.
  2. The private property of any partner shall be applied first in payment of his private debts and the surplus, if any, may be utilised for payment of the firm’s debts, in case the firm’s liabilities exceed the firm’s assets. 

Firm’s Debts


Private Debts


Debts owned by the firm to the outsiders


Debts owned by a partner in his/her personal capacity e.g. Home Loan fm Bank


Utilization of Firm’s Property


Utilization of Partner’s Property


(a) Firm’s Debts


(a) Private Debts


(b) Private Debts


(b) Firm’s Debts


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